Shakeout continues with financial probes

As we closed for press came WorldCom's disclosure that it has booked USD3.8bn of ordinary expenses as capital expenditure, thus spreading them over many years and fraudulently making the company appear profitable in 2001 and Q1/2002 when it was, in fact, making large losses.

This particular accounting irregularity might be confined to WorldCom, and the stock markets seems to have not been hit too badly in the short term. However, there is widespread speculation that this sort of over-inflation of profits could be just the tip of the iceberg, with "new economy" sectors such as telecoms perhaps the most suspect. Also, while WorldCom is a US company listed on NASDAQ, the multi-national nature of many companies (in an industry that is almost by definition global) means that the ripples of caution are spreading far and wide.

The US Securities and Exchange Commission was already investigating WorldCom on other matters before the latest disclosure. However, it is also investigating other companies such as the bankrupt Bermuda-based Global Crossing as well as US-based Qwest Communication International, which is a co-parent of bankrupt Netherlands-based KPNQwest (see page 10). Both have extensive networks in Europe.

An immediate consequence of KPNQwest's bankruptcy is the imminent shut-down of a pan-European data network that was catering for 40% of all European Internet traffic. Both the administrators and the companies concerned have been fighting hard to keep the network operational for as long as possible - at least while users could find alternative service providers. However, the failure to sell the whole company and its network as a going concern - followed by the imminent break-up into its national subsidiaries and piecemeal sale - threatens significant short-term disrpution of services and long-term loss of investor confidence. In the case of KPNQwest, banks and bondholders are demanding investigation into why bankruptcy came in May just weeks after a positive financial forecast and bank-loan in April, such that an EU Commission investigation may result.

What may cause more widespread impact is the common practice among many telecoms companies of booking network-capacity swaps and reservations as revenues. The effect is the inflation of profits for what - in the event of an industry downturn and paucity of expected network revenues - can in fact be loss-making companies.

The emergency mode in which the industry currently finds itself was much in evidence at the SuperComm exhibition (see page 14), where much new technology is now focused on reducing operational expenditure and evolving existing infrastructure for new, more efficient, value-added services.

But, to look on the positive side long-term, the bankruptcy - albeit high profile - of a company such as KPNQwest is probably not only inevitable but also a sign that the over-capacity in the market is being eliminated. While traumatic for the many individuals involved directly who may lose their jobs, the telecoms industry as a whole is working through a natural correction and should emerge "right-sized". Surviving companies will benefit from the new technology distilled from failed start-ups. But - more importantly, in the light of the painful learning experience of the technology-led new economy - they will also benefit from the new focus in the industry: the services that the customer actually wants, rather than simply building network capacity.